The Complete Guide to the working of IR-35
What is IR-35?
IR-35, also known as the payroll working rule, is a piece of legislation passed to ensure that contractors pay the correct amount in taxes and national insurance. It prevents workers from avoiding taxes by using intermediaries or middlemen. It also ensures that people who should be considered employees of a company aren’t disguised as contractors.
IR-35 was brought forward by the HMRC (HM Revenue and Customs) in the year 2000 by Gordon Brown, the chancellor at the time. Its ultimate aim is to increase compliance amongst those who are in business for themselves and to guarantee that the correct amounts of taxes and national insurance are met by contract workers. IR-35 also works to prevent tax evasion through disguised employment.’
The complex nature of IR-35 and its lack of regard for the separation between an actual self-employed contractor and an employee has been a point of contention.
Who qualifies for IR-35?
If a contractor can be considered an employee, by offering his or her services directly, but instead uses a middle-man, then he or she is qualified for IR-35.
When are you inside and outside IR-35?
Several factors are used to determine if a person qualifies for IR-35:
Job equipment: If the contractor works at the employer’s office with tools and materials provided by the employer, he or she fits the definition of an employee and thus falls inside IR-35. Someone working from home with tools and materials purchased for the business is a contractor and not eligible for IR-35.
Benefits: If the employee does not receive an extra incentive for overtime, sick days, pension contributions, maternity leave, etc., then that employee would be considered a contractor and cannot fall within IR-35. If a contractor does receive employee benefits, then he or she is an employee and qualifies for IR-35.
Financial risk: A worker who bears the cost of the business, i.e., tools, materials, maintenance, etc., is considered self-employed. A worker who isn’t responsible for the business costs is considered as an employee.
Payment: If the worker is paid on a wage or salary basis, then he or she fits the definition of an employee and falls within IR-35. If the worker is paid on hours worked basis or on a contingency basis, he or she is a contractor and should not be subject to IR-35.
Using these guidelines, it should be simple to determine who falls within IR-35 and who doesn’t, however, these are just guidelines and there are many other things that can be considered when checking if you come within IR-35 or not. Speak to a suitable contractor accountant for guidance or ask them for a contract review to determine your risk level.
What happens if you are caught inside IR-35?
A contractor who is caught by IR-35 is considered an employee of the company retaining his or her services. This requires him or her to pay the same level of income tax and national insurance contributions an employee would on their deemed income. If you have been operating as a contractor under IR-35 for several years, the consequences of being picked by HMRC can be severe, you will need to calculate deemed payment on your limited company income and not what has been extracted, you are allowed a 5% expense allowance plus any pension contributions. HMRC can go back at least 6 years and will charge interest and penalties as well.
If you as a contractor come under IR-35 you have a few options:
You can get employed as an employee instead of a contractor and operate on the employer’s payroll. This means you will have the same rights as an employee and will be taxed similarly as other employees through PAYE.
The other option is to work through an Umbrella company, a PAYE Umbrella company is a normal UK limited company. The purpose of this company is to act as an intermediary employer acting on behalf of its contract employees. The umbrella operates a similar payroll structure to an employer, however, the added benefit of using an umbrella is that they are able to claim allowable deductions before paying you which increases your take-home pay slightly compared to if you were directly employed by the company retaining your services.
As a company retaining services of a contractor, it would be wise to advise the contractor of their IR-35 risk level, as the rules around the risk of IR-35 have changed in the public sector and are changing in the private sector. A company whose contractor comes under IR-35 should think about hiring the individual as an employee and should take off VAT due, cost of materials used by the worker, tax-deductible expenses that no longer apply and NICs (National Insurance Contributions). A report of the payment is made to the HMRC by a Full Payment Submission, similar to how it is handled with other employees. The worker can be added to the payroll system and the payments must be reported under a PAYE scheme.
IR-35 can get tricky very quickly, intermediaries are also at huge risk of non-compliance after new reporting requirements were introduced for Employment Intermediaries. Our team of dedicated contractor accountants are at hand to help and guide you in the best possible and the safest way. Speak to us to find out more.
Differences of IR-35 in Public Sector vs. Private Sector
Public sector contracts and private sector contracts have different rules under IR-35:
In the public sector, the employer must determine whether or not the contract worker is an employee. If the contract worker qualifies for IR-35, tax and NIC deductions will be made from their salary, and a report must be filed with the HMRC
The private sector has the contractor determine if he or she falls within IR-35. If he or she does, the tax and NICs due must be paid by the contractor.
A reform of the rules is set to go wide in 2020, read More about the consultation on the new rules.
Tips to Reduce IR-35 Risk When Contracting
If a contractor has control of how he or she performs the assigned tasks, the contract has less probability of falling with IR-35. Having the contract specify work start and finish times, or specific days indicates employment.
Also, if a client insists on overseeing your work most of the time, and offers direction on how the work should be completed, or requests that you perform tasks that fall outside the agreed job that can indicate employment.
If you are allowed to send another person to do the work contracted to you, the contract will fall outside IR-35.
Also, if the client is under an obligation to give you work and pay you for it and if you are also under an obligation to do the work and take the payment, this constitutes employment.
Contract work implies working from project to project. After a project is completed, your obligations towards the client and their obligations towards you have ended.
The ability to work for other clients simultaneously is another factor if a client’s contract prohibits you from seeking out and working for other clients while in their service, that could be seen as employment.
Changes expected in the coming years
A new government policy was implemented in 2017 that made the clients in the public sector responsible for a contractor’s IR-35 status. Negative feedback to this policy did not faze the government, the government now has plans to extend this policy into the private sector, this was announced in the 2017 Budget.
A consultation was opened into IR-35 after some problems were identified in the existing reforms. HMRC has requested for stakeholder views and feedback on IR-35 reformation and its use in the public sector. The consultation began in March and will close on May 28. The initial results should be released in the summer with the next Finance Bill and finalized later in the year.
How to Find Good Contractor Accountants
If you are a contractor working through your limited company, handling all the affairs associated with your business might prove difficult. Contractor accountants are specialists you can hire to sort out all the compliance affairs for you. The accountant will help with your year-end account submissions, VAT returns, payroll management, corporate tax, dividends, self-assessments, efficient extractions etc.
Choosing good accountants for contractors is important, so picking the right one must be done carefully.
- Check the accountant’s qualifications properly, they should be ACCA or ICAEW qualified.
- Choose a specialist who understands your needs, make sure they understand how contractors operate.
- Get references from other contractors
- Confirm the services offered at that price range
- Ensure that the accountant understands IR-35
- Ensure that the accountant is conversant with Managed Services Company (MSC) legislation.
Clear House Accountants are specialist Accountants in London who have years of experience working with thousands of contractors from a variety of industries. Our industry expertise, smart solutions and specialist extraction services for contractors make us the best choice for your contractor business. Speak to us to learn more.